If we get spending under control, we can make the reforms to the tax system
that would secure our future prosperity, argues John O'Connell of the
TaxPayers' Alliance

Complexity is expensive. That’s just as true of tax systems and economies as it is of manufacturing processes and prices.

And few things are as maddeningly complex as the British tax system.

As rising powers in Asia, South America and elsewhere develop increasingly competitive legal systems, workforces and infrastructure, our unwieldy and cumbersome tax code is becoming an obstacle to investment and growth that we can no longer afford to ignore.

Just look at the difference between our tax system and Hong Kong’s – at over 17,000 pages, a pile of Tolley’s Tax Handbooks tower over their 267-page counterpart.

Complicated taxes put significant burdens on businesses. Small firms, in particular, are at a big disadvantage, having to negotiate that labyrinthine system with limited resources.

Worse still is tax uncertainty; with annual Finance Acts running to hundreds of pages, making sensible business decisions for the long term becomes all the more difficult.

Despite recent optimism, the economy remains mired in a long period of sluggish growth and poor productivity. But we can do something about it. Radical reforms to business taxes will help to pull us out of the mire.

The final report of the 2020 Tax Commission, which the TaxPayers’ Alliance ran with the Institute of Directors, recommended sweeping reforms to the tax system. The key proposal was a single proportionate tax of 30pc above a generous personal allowance.

This would cut tax for everyone, because even if you ignore the employer’s National Insurance, the current basic rate of tax is actually 32pc once the employee’s contributions are factored in.

Of course, we shouldn’t ignore employers’ contributions. In the same way that your TV doesn’t pay the TV licence, ultimately business doesn’t pay taxes. People do. High taxes supposedly on businesses always mean lower wages for workers, lower returns for shareholders or higher prices for customers.

So the commission proposed abolishing taxes on capital and labour disguised as business taxes. They should be replaced with a single tax on distributed income levied at the same rate as labour income.

Incentives for entrepreneurs would improve substantially without corporation tax, capital gains tax and inheritance tax. If they were replaced with a single tax on capital income, the top marginal rate on income earned, saved, invested in a company and passed on to children would be significantly cut.

Not only would this make economic sense by substantially sharpening incentives, it would also remove large swathes of the loopholes and ambiguities in the system that make it opaque and untrustworthy.

Sounds good, doesn’t it?

But there’s a big, big problem – the Government still spends far too much of our money for such a lean system to be realistic. And for all the talk of austerity, spending will still be 43pc of GDP by 2015, according to OBR projections.

To implement the kind of reforms proposed by the 2020 Tax Commission, we need to reduce spending to around 33pc of national income. Rolling back spending to this level needn’t mean destitution. The governments of Australia and Switzerland spend roughly that share of their economies. There are differences between theirs and ours, but they show that spending a third of your national income doesn’t equal disaster. There has been a lot of talk of austerity, but it perhaps hasn’t happened on a scale that matches the publicity.

But credit where credit is due – many departments and councils have gone on major efficiency drives, trimming the fat and improving processes. The Cabinet Office is doing a lot of working on improving IT procurement, for instance, which has been a thorn in the side of successive governments.

But, looking at the bigger picture, there is still far too much wasteful spending going on, from the humble town hall all the way up to the European Commission.

Big savings are there to be made. The National Audit Office found that better use of public sector office space could save £830m. Civil servants are still entitled to 2.5 “privilege days” off, for the Queen’s birthday and Maundy Thursday. This costs taxpayers around £180m a year.

We could save £1bn by prescribing whichever is the cheapest between generic drugs and the branded alternative.

And the new TaxPayers’ Alliance War on Waste campaign will pick out smaller cases of profligacy as well, such as the £70 spent by the Forestry Commission on a bunny suit. It might seem like a trivially small amount of money, but it matters: somebody worked for that £70 and had it taken from their wages. Changing the mindset of public servants, so that they act as responsible guardians of taxpayers’ money, is crucial.

But for a long-term, sustainable reduction in the size of the state we also need to re-think what it actually does. The size and scale of the quango state must be properly addressed, too. When the coalition Government came to power in 2010, some organisations – like Becta, an IT supplier for schools – were put out to pasture immediately. Other so-called abolitions were less impressive, though.

Government funding of charities has grown over recent years. In fact, according to research by the Institute of Economic Affairs, 27,000 charities are dependent on the Government for over 75pc of their income. Not only is this a pernicious development for charity independence, it also indicates that the state’s tentacles are too far-reaching.

Of course, structural reforms and re-thinking the role of the state will take time. But it is the big challenge facing the next government, regardless of its political make-up.

Health care and pensions are only going to become more costly in the near future and we need a proper discussion about how we finance them in the long term.

Growth-maximising spending levels are far lower than the current 44pc of GDP. There is an extensive body of academic literature out there backing that up. At the moment, the state is simply too big and most politicians don’t have a solution.

But if we get spending under control, we can make the reforms to the tax system that would secure our future prosperity.